Trusts and Foundations
Settlor’s reserved powers and trustee’s
limited liability – are private foundations
the best of all worlds?
By Paolo Panico,
Private Trustees SA,
Luxembourg and Geneva, Switzerland
ince Jersey and the
Seychelles joined the league
in 2009, seven common law
or mixed jurisdictions have
added ‘private foundations’ to their
range of wealth management
solutions. The first path-breaking
exercise was attempted with the St
Kitts Foundations Act 2003, followed by
The Bahamas Foundations Act 2004, the
Nevis Multiform Foundations Ordinance
2004 and, in due course, the Antigua and
Barbuda International Foundations Act
2007, the Anguilla Foundation Act 2008
as well as, eventually, the Foundations
(Jersey) Law 2009 and the Seychelles
Foundations Act 2009.
These private foundations are
creatures of statute, shaped according
to the corresponding civil law
institutions that, for private purposes,
were first epitomised in the
Liechtenstein Law of Persons and
Companies (Personen- und
Gesellschaftsrecht, PGR).
They are quite different in nature
from the corporate vehicle that has
traditionally performed the
corresponding functions in common law
jurisdictions, i.e. the company limited by
guarantee, a detailed regulation of which
can be dated back to the English
Companies Act 1862. Guarantee
companies and hybrid companies
featuring guarantee members and
shareholders exist under the laws of
most common law jurisdictions that
follow the English (as opposed to the
US) legal model, ranging from the UK
and the Republic of Ireland to, most
notably, the Isle of Man, Gibraltar, the
Cayman Islands, The Bahamas, the British
Virgin Islands and the Channel Islands.
As a result, both variants of ‘private
foundations’ exist in some jurisdictions,
such as Jersey and The Bahamas. The
common feature they share, and that
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constitutes the primary structural
difference between foundations and
trusts, is legal personality.
Indeed, the very notion of ‘juristic’
or ‘legal personality’, which is the
essential characteristic of corporate
entities, was originally thought up in
respect of foundations. It was in the
13th century that Sinibaldo de’ Fieschi, a
commentator to the Roman civil code
who became pope under the name of
Innocent IV, suggested that a monastery
“should be deemed to be a person”
(fingatur una persona). This legal fiction
allowed monks to accept and to hold
property in the name of the monastery
without offending their vows of poverty.
Foundations were thus the first
institutions to be recognised as separate
corporate entities, to the extent that
they were established for charitable
purposes (piae causae), as they still are
under the laws of most continental
European jurisdictions. In England the
same function was performed by
charitable trusts and there are
speculations about the common origin
of the two institutions. Some points of
contact exist also with waqfs, the
corresponding Islamic devices for the
appropriation of assets to charitable
ends.
It was not until 1926, with their
statutory recognition under § 552 of the
Liechtenstein PGR, that foundations
(Stifungen) could be incorporated for
family or private purposes. Private
foundations gained an increased
international popularity as estate
planning and asset protection tools as a
result of the Panamanian law of 12 June
1995 n 5 on ‘private interest
foundations’ (fundaciones de interés
privado). Most recently, the Liechtenstein
model legislation underwent a thorough
overhaul that came into force as of 1
April 2009.
Foundations are radically different
from trusts from a structural point of
view. The former are corporate entities,
or ‘juristic persons’, while the latter are
legal relationships between trustees and
beneficiaries. On the other hand, from a
functional point of view, private
foundations can be created for the same
asset protection or estate planning
purposes for which property may be
settled on a private express trust.
An intriguing question is then why a
number of common law jurisdictions,
some of which feature highly
sophisticated pieces of trust legislation,
have felt the need to fit an essentially
civilian statutory creature into their legal
systems.
Two aspects stand out, in respect of
which private foundations appear to
offer an ingenious solution to some
shortcomings of the traditional English
trust. They are: (i) the settlor’s ability to
retain powers without jeopardising the
validity of a trust and (ii) the unlimited
personal liability of trustees. To be sure,
the benchmark for this discussion is the
trust according to English equitable
principles. Of course, trust law varies –
and in some respects quite significantly –
across the multitude of trust
jurisdictions around the world. Private
foundations legislation is less diversified,
yet different approaches are available
under the laws of the individual
jurisdictions. Accordingly, some degree
of generalisation is inevitable.
Founder’s – as opposed to
settlor’s - reserved powers
Foundations come into existence as
a result of some formal incorporation
process that usually involves registration
with a competent registrar. As a result,
such registrar may issue, on request, a
certificate of registration or of good
standing similar to the corresponding
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Trusts and Foundations
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documents issued in respect of
international business companies and
evidencing the existence and good
standing of the foundation.
As a result of such process,
foundations acquire ‘legal personality’ and
exist as separate legal entities. By an
extension of the authority in Salmon v
Salmon & Co Ltd1, the assets transferred
to a foundation are separate from those
of the founder. Some statutes spell out
this principle in unequivocal terms. A
widely followed example is section 67 of
the St Kitts Foundations Act 2003:
Assets irrevocably transferred to a
foundation shall:
(a) become the assets of the
foundation;
(b) cease to be the assets of the
founder; and
(c) not be the assets of a beneficiary
unless and until distributed to such
beneficiary.
It is generally submitted that a
consequence of the ‘incorporated’ nature
of foundations is the founder’s ability to
retain a potentially wide range of
dispositive as well as administrative
powers. As a result of the House of
Lords decision in Salmon, the
circumstance that the same person is the
main shareholder and the sole director
of a company does not undermine the
very existence of such company as a
separate legal entity. The same principle
should apply to foundations. Indeed,
some statutes expressly provide for the
‘charter’ or ‘articles’ of a foundation - ie
the confidential document containing a
detailed regulation of its functioning – to
include provisions for the reservation of
rights and powers to the founder2.
Section 27 of the Seychelles Foundations
Act 2009 contains a detailed list of the
items that the founder may direct or
approve:
(a) investment activities of the
foundation;
(b) amendment of the charter or
regulations;
(c) appointment or removal of a
councillor;
(d) appointment or removal of any
supervisory person;
(e) rights, entitlements and restrictions
of a beneficiary;
(f) addition or exclusion of a
beneficiary;
(g) proposed continuation of the
foundation as a foundation
registered or otherwise established
under the written laws of a
jurisdiction other than Seychelles;
(h) dissolution of the foundation.
Section 7(2) of the Anguilla
Foundations Act 2008 provides for the
founder’s default power of revocation or
amendment of the declaration of
establishment of a foundation.
In addition to any statutory powers
provided for under the relevant
legislation, the founder may exercise a
significant influence on his foundation if
he acts as ‘guardian’; a supervisory office
similar to that of a trust protector.
The corresponding situation of trust
settlors is quite different. With the
exception of a limited (yet increasing)
number of offshore jurisdictions
expressly admitting ‘reserved powers
trusts’3, a settlor retaining any
combination of the powers above would
seriously undermine the very existence
of the trust and cause it to fail as ‘sham’.
The Cayman Islands Court of Appeal,
with its unreported judgment in Tasarruf
Meduati Sigorta Fonu v Merrill Lynch Bank
and Trust Company (Cayman) Limited of 9
September 2009, provided an important
confirmation that ‘reserved powers’
legislation is upheld in its home
jurisdictions. However, such
arrangements are quite likely to be
disregarded in any jurisdictions practising
and recognising trusts according to the
traditional equitable model.
For the avoidance of doubt, the
Jersey customary rule donner et retenir ne
vaut, which was at the basis of a widely
discussed (and probably overemphasised)
sham doctrine after the ‘Rahman case’4, is
expressly repealed under Article 33 of
the Foundations (Jersey) Law 2009 in the
same way as it was ruled out under the
2006 amendment of the trusts law5.
This is perhaps the most energetically
advertised feature of private foundations.
They are allegedly fit for clients with a
civil law background, who would be
unlikely to really grasp the trust concept,
and, more generally, they appear to
accommodate every settlor’s unuttered
dream to retain substantial control over
‘his’ trust property.
This proposition is largely untested
to the extent that no case law is available
for the time being. On the other hand,
some precedents on ‘sham companies’
have existed for nearly a century. James
Wadham’s article in an earlier issue of
this journal makes a salutary reading to
this effect6. For instance, in Gilford Motor
Co Ltd v Horne7 a company purportedly
created by the defendant’s wife was held
to be a ‘cloak or sham’ to breach his
contractual obligations to the plaintiff. In
Trebanog Working Men’s Club ad Institute
Ltd v Macdonald8, a club was held to act
as trustee for its members. An elaborate
discussion of the ‘sham company’ notion
was rehearsed (albeit unsuccessfully) by
the Australian Federal Court of Appeal in
Re Sharrment Pty Ltd9.
Furthermore, tax authorities may
disregard the legal nature of foundations
for their own purposes and classify them
as trusts or as companies so to maximise
revenue. A recent example is the IRS
Chief Counsel Advice Memorandum
AM2009-12 of 7 October 2009,
attempting to classify Liechtenstein
Stiftungen and Anstalten. More generally,
the application of the OECD ‘effective
management and control’ test may be
relevant for founder-driven private
foundations, if not to deny their
existence as legal entities, at least to
establish their residence for income tax
purposes. To the extent that the founder
is unlikely to be resident in the same
offshore jurisdiction of incorporation of
the foundation, this point should be
carefully considered in any wise planning
exercise.
Councillors’ – as opposed to
trustees’ – contractual liability
The ‘reserved powers’ feature
discussed above is mostly meant to
appeal to would-be founders or settlors,
i.e. ‘the clients’. On the other hand,
another aspect of private foundations,
equally deriving from their ‘corporate’
nature’, may be particularly significant for
service providers deciding to act as
foundation ‘councillors’ rather than as
trustees.
To the extent that trusts are not
separate legal entities, they cannot trade,
hold property, sue or be sued in their
own right. Trustees are the legal subjects
that do all these things. As a result,
under the traditional English model,
trustees are prima facie personally
answerable for the liabilities they incur in
the exercise of their fiduciary duties. In
turn, to the extent that they did not
commit a breach of trust, they have a
right of indemnity to recoup their
expenses out of the trust fund. A clear
statement of this principle can be found
in Vacuum Oil Company Pty Ltd v Wiltshire,
an Australian High Court decision
relating to the widespread Antipodean
practice of ‘trading trusts’10:
In respect of debts incurred [by the
trustee] in so carrying on the business he
is personally liable to the trading
creditors – the debts are his debts.
A Victorian authority for this
inflexible principle was the House of
Lords decision in Muir v City of Glasgow
Bank11, where the circumstance that
certain trustees were entered as ‘trust
disponees’ for the named beneficiaries in
the shareholders register of a bank did
not relieve them from the unlimited
liability implied under the bank articles
(the bank was organised on a copartnership basis). More than a century
later, in Marston Thompson & Evershed plc
v Bend12, the trustees of a rugby club
entered into a loan agreement expressly
describing them as trustees, nevertheless
they were held personally liable to repay
the debt as the club property was not
sufficient to that effect. Even a practising
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means of provisions purporting to limit
the personal accountability of trustees
for properly incurred liabilities. An
eloquent example is article 32(1)(a) of
the Trusts (Jersey) Law 1984, as amended
by the Trusts (Amendment No. 4)
(Jersey) Law 2006:
Where a trustee is a party to any
transaction or matter affecting the trust,
if the other party knows that the trustee
is acting as trustee, any claim by the
other party shall be against the trustee
as trustee and shall extend only to the
trust property.
These statutory solutions stretch the
notion of trusts and extend to them
some of the features of corporate
entities. An alternative approach is
indeed to opt for a separate ‘juristic
person’ performing the same functions
of a trust, as it is the case of private
foundations.
Given their civil law origin, private
foundations derive their constitutive
principles from contract law, as opposed
to equity. As a result, the duties of the
officers in charge of their administration,
who are usually described as ‘councillors’
or ‘council members’, are contractual –
not fiduciary – in nature. A clear
statement to this effect can be found in
section 11(1) of the Bahamian
Foundations Act 2004, making it clear
that ‘[t]he duties and responsibilities of
an officer shall be primarily
administrative, rather than fiduciary in
nature’. Article 25(1)(b) of the
Foundations (Jersey) Law 2009 goes a
step further and specifies that: ‘a
beneficiary under a foundation is not
owed by the foundation or by a person
appointed under the regulations of the
foundation a duty that is or is analogous
to a fiduciary duty’.
As a result of the contractual nature
of their duties, and to the extent that
they abide to the statutory duty of care
imposed on them under the relevant
legislation, private foundation councillors
are not personally liable for the
obligations they undertake in the
exercise of their function. To this
purpose, section 33(1) of the Bahamian
Foundations Act 2004 provides that:
No officer of a foundation shall be
personally responsible for any liability of
a foundation unless such liability shall
have been incurred as a result of his own
gross negligence, wilful default or
misconduct, fraud or dishonesty.
Under the same token, section 23 of
the Anguillan Foundation Act 2008
provides for a limitation of liability in
respect of the exercise of the council
members’ powers with the prior
authorisation of the ‘guardian’.
Let us go back to trusts by way of
conclusion. The personal creditors of
trustees are barred from attaching the
trust property. This is a quintessential
principle of trust law and as such it was
incorporated into the Hague Convention
of 1 July 1985 on the Law Applicable to
Trusts and on their Recognition, under
which trusts have made their way into a
number of civil law jurisdictions. The
opposite principle does not apply, or at
least not in all trust jurisdictions. In
other words, trustees are personally
liable to the trust creditors under the
laws of England and of many
Commonwealth jurisdictions closely
following the English approach. This is a
source of potential nuisance to trustees,
beneficiaries and any third parties
dealing with trusts. Some statutory
solutions following the US model have
the side effect of transforming the trust
into something similar to a corporation.
Private foundations can be an alternative
solution, relying on the features of ‘legal
personality’ and effectively limiting the
liability of service providers.
Trusts and Foundations
lawyer could end up overlooking this
principle, as it happened in AMP v
MacAlister Todd13, a case recently heard by
the Supreme Court of New Zealand,
where a solicitor trustee failed to realise
that the liability for the Goods and
Services Tax payable on the sale of some
trust property is a personal liability of
trustees.
However deeply rooted in the
English legal tradition – and perhaps in
the very essence of the trust as a legal
institution – this revered principle gives
rise to a twofold set of drawbacks that
were identified by the English Trust Law
Committee in its 1999 Report on ‘Rights
of Creditors against Trustees and Trust
Funds’. On the one hand, the potential
hurdles to the operation of the trustee
indemnity may impair the trust
creditors’ ability to have their claims
satisfied out of the trust fund14. On the
other hand, the personal liability of
trustees may have an adverse impact on
their ability to effectively administer
their trusts or it may increase their
costs of risk management and
professional insurance, which in turn
means higher trusteeship fees to the
detriment of the beneficiaries.
Personal exposure to unlimited
liability may have induced effective selfdiscipline for the individuals acting as
trustees in Victorian England, yet it is
likely to be far less relevant at a time
when the trust business is mostly
performed by regulated professionals
and financial intermediaries.
The modern US approach, as
expressed in uniform state law, has
traditionally differed from the English
one. For instance, section 7-306(a) of the
Uniform Probate Code contains a
statement to the effect that ‘a trustee is
not personally liable on contracts
properly entered into in his fiduciary
capacity in the course of administration
of the trust unless he fails to reveal his
representative capacity and identify the
trust estate in the contract’. An
equivalent statement can be found in the
Uniform Trust Code15. The notion of a
trust as a separate legal entity is well
grounded in the US practice and it dates
back to the early 20th century, when the
‘Massachusetts trust’ used to function as
a holding company. A significant
development of this concept is the
Delaware ‘business trust’, renamed as
‘statutory trust’ as of 1 September 2002,
that is expressly described as ‘a separate
legal entity’16, as well as the Uniform
Statutory Trust Entity Act, the latest
draft of which was approved by the
National Conference of Commissioners
on Uniform State Laws at their July 2009
meeting in Santa Fe, New Mexico.
This issue is addressed in the trust
laws of many offshore jurisdictions by
END NOTES:
1. [1897] AC 22.
2. St Kitts, Foundations Act 2003, s 61(2)(a);
Bahamas, Foundations Act 2004, s 6(2)(a);
Foundations (Jersey) Law 2009, Art 18(1).
3. Nevis, International Exempt Trust
Ordinance 1994, s 47; Cook Islands,
International Trusts Act 1984, s 13C;
Cayman Islands, Trusts Law (2007
Revision), ss 13 – 15; Bahamas, Trustee Act
1998, s 3; Trusts (Jersey) Law 1984, Art 9A;
Trusts (Guernsey) Law 2007, s 15.
4. Adel Rahman v Chase Bank (CI) Trust
Company Limited [1991] JLR 103.
5. Trusts (Jersey) Law 1984, Art 9(5), inserted
by the Trusts (Amendment No. 4) (Jersey)
Law 2006.
6. J.A.F. Wadham, ‘First the sham trust, now for
the sham company’, Offshore Investment,
December/ January 2003, p 40.
7. [1933] Ch 935.
8. [1940] 1 KB 576.
9. (1988) 82 ALR 530.
10. (1945) 72 CLR 319, 324.
11. (1879) 4 App Cas 337.
12. (1997) Law Society Gazette 94/39, 15
October 1997.
13. [2007] 1 NZLR 485.
14. A coverage of this issue is outside the
scope of this article but the readers who
will bear with a self-quotation may find a
detailed discussion at chapter 6 of P.
Panico, International Trust Laws, Oxford
University Press, 2010.
15. Uniform Trust Code, § 1010.
16. Delaware Code, Title 12, § 3801.
“Foundations and Trusts –
Some Thoughts”
May 2009, Issue 196
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